Hardware Companies “Selling” Software

Software companies have much better margins and are a zillion times more profitable. Why is that?

If you’re trying to defend hardware companies, you would say, “that’s because software companies have much lower costs.” That’s a true statement. But still …

Hardware companies have been absolutely brainwashed into always thinking about costs when they price. They are addicted to cost plus pricing. They constantly focus on margin.

Then they decide to innovate. They decide to create a software product that adds additional value to their hardware. Sometimes significantly more value. And you know what they do? They give it away! Oh, they put a price on it, but the salespeople throw it in to close the deal. Why not? There wasn’t any cost associated with it.

This makes me want to pull out what little hair I have left.

If software companies gave away their software because there wasn’t any cost, they wouldn’t make any money. They don’t, and they make a lot of money. Hmmmm.

There is an accounting practice used by software companies that is completely wrong for pricing, but maybe hardware companies should adopt this. Software companies take their total development budget and use that as their cost. They divide this by the number of units they expect to sell to calculate a cost of goods sold. Then they price above that so they make a profit. This is horrendous pricing practice, but I think hardware companies should adopt it.

Here’s the difference. Hardware companies have hard costs. Speaking financially, they can correctly and accurately calculate COGS. They don’t allocate their engineering overhead to costs. Hence, when they add a software product, where there are very little hard costs, they don’t add anything to the COGS. Salespeople have always known they can convince management to accept a deal as long as it’s slightly above COGS, so they give away the software.

What if hardware companies implemented accounting like software companies? Their calculated COGS would be higher for their hardware and more importantly for their software. Sales wouldn’t be able to easily throw in the software for free. It comes right out of the margin.

To be fair, software accounting for pricing is so wrong in so many ways, but when it comes to sharing COGS with sales, maybe they are on the right track. It may make sense for hardware companies to adopt the same (wrong) accounting practice.